Bank results show signs of credit deterioration

But problems with riskier mortgages may not spread, analysts say

By

AlistairBarr

SAN FRANCISCO (MarketWatch) -- Fourth-quarter results from several banks suggest the benign credit environment of recent years has begun to deteriorate and could restrain future earnings, analysts said on Wednesday.

Still, credit problems are mostly restricted to subprime and other riskier mortgages right now and shouldn't spread to other areas of the lending industry, the analysts added.

IndyMac Bancorp Inc.
NDE
which sells so-called Alt-A mortgages, said Tuesday that fourth-quarter earnings will come in well short of analyst expectations because of increased costs from loan losses and delinquencies. (Alt-A loans are for borrowers who don't have good enough credit to buy prime loans, but have enough standing to avoid tapping the subprime market.)

Shares of the Pasadena, Calif.-based lender have slumped roughly 10% since Tuesday's announcement.

Other lenders also reported credit deterioration this week. Marshall & IIsley
MI, +3.03%
reported a jump in non-performing assets in the quarter, while Bank of the Ozarks
OZRK
reported a 69% increase in problem loans, albeit from very low levels.

"Credit has been tailwind for this industry for several years, but it's becoming a slight headwind now."
-- James AckorRBC Capital Markets

"Credit has been tailwind for this industry for several years, but it's becoming a slight headwind now," said James Ackor, an analyst who covers IndyMac and other lenders at RBC Capital Markets.

"Credit has been so good for so long -- particularly in the mortgage market, which has been supported by an incredibly robust housing market," Ackor continued. "Credit being cyclical and with a deterioration in pockets of the housing market, it stands to reason that the environment will deteriorate."

Foreclosures jumped 35% in December versus a year earlier, RealtyTrac said Wednesday. For the fifth straight month, more than 100,000 properties entered foreclosure because the owner fell behind on loan payments, the firm noted.

IndyMac has been hit by rising delinquencies in its main Alt-A mortgage portfolio, but also by problems in its smaller subprime lending business, Ackor added.

The company sells on its subprime mortgages into the secondary market, but the loans have standard representations and warranties that allow buyers to return the loans if the borrower goes delinquent within 90 days, the analyst explained.

Indeed, Ackor and other analysts noted that most of the pain is still restricted to the subprime market.

"The key piece of news is that this remains a subprime problem and hasn't spread to other parts of the mortgage market," Jeffrey Harte, an analyst at Sandler O'Neill, said.

"The question has been whether this is symptomatic of growing problems in the wider world of credit, or a specific issue related to lax lending standards in the subprime space six months back," he added. "So far it seems to be a lack of pricing discipline from some subprime originators."

Just over 11% of the value of subprime mortgages were delinquent by 60 days or more in November, according to LoanPerformance, a unit of First American Corp.
FAF, -0.04%
that crunches data for the industry. That's up from 7.5% a year earlier.

That deterioration has shown up in the performance of companies that specialize in subprime lending. Shares of New Century Financial
NEW, -3.80%
have lost more than 22% in the past three months, while Novastar Financial
NFI, +0.04%
stock has dropped more than 30%.

Mortgage Lenders Network USA, which specializes in subprime mortgages, had to be bailed out by Lehman Brothers
LEH
last week, while rival Ownit Mortgage Solutions filed for bankruptcy in late December.

Past increases in subprime delinquencies have usually been accompanied by rising unemployment, RBC's Ackor noted. That hasn't happened this time, which suggests problems have been caused by deterioration in lending standards, he said.

"This is going to be a sizable speed bump, but it will only be an outright disaster if interest rates rise sharply or unemployment rises sharply," the analyst concluded.

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